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'The Sales Ledger account should be debited with the total amount due on account from customers and each account in the sales ledger should be debited for the balance due. At the same time, each customer's account in the general ledger should be credited with the balance due. Note that the debit entry is really posted twice: First, in one sum to the debit of the controlling account in the general ledger; second, to the debit of each customer's account in the sales ledger, in amount as shown on the schedule of accounts receivable. Since, however, the sales ledger is considered a subsidiary ledger and will not necessarily be taken into consideration when preparing a Trial Balance, the double posting of the debit item will not affect the equilibrium of the general ledger. After the entry has been properly posted all customers' accounts in the general ledger will be in balance, but each account in the sales ledger will show balance due on account. The Sales Ledger account in the general ledger will show the total amount due from customers.

Accounts with customers in the sales ledger are debited and credited with the individual transactions in the same manner as though they were a part of the general ledger. In other words, all transactions recorded in any of the books of original entry which affect a customer's account will be posted to the customer's account in the sales ledger. The Sales Ledger controlling account will also be debited for all sums posted to the debit of the individual accounts in the sales ledger and will be credited for all sums posted to the credit of the customers' accounts in the sales ledger. However, the controlling account is a summary account and usually the posting to this account is done at the end of each month, only the totals being posted from each book of original entry. For instance, special columns may be provided in the journal, cash book, sales returns book and notes receivable book, and the totals of these columns may be posted at the end of the month. Where no special columns are provided, then the individual items will be posted. After all posting has been done the Sales Ledger account will show the total amount due from customers. This can be verified by preparing a schedule of the balances of the accounts with customers from the sales ledger.

Discounts. In the treatment of the accounts with customers, the subject of trade and cash discounts will come up. There has been considerable discussion by accountants with regard to the proper treatment of discounts. It is not considered good policy to permit trade discounts to appear in the ledger at all. In billing customers, trade discounts should be deducted from the invoices before they are mailed out. Likewise, before invoices are entered in the purchases record, all trade discounts should be deducted.

A trade discount is usually a deduction from the list price regardless of the time of payment. Even though the terms of the invoice indicated that the discount would not be allowed

after thirty days, if the rate were greater than 2%, it would seem to be a trade discount, for it is apparent that anyone would most certainly take advantage of any such discount even if it were necessary to borrow the money at the bank paying 6% interest. It certainly would be better policy to pay 6% annual interest on borrowed money than to lose 2% discount per month on purchases. Mr. Montgomery, says:

“The distinction, therefore, is based on the answer to the query: Is the rate one which is obviously granted for anticipation of obligations not due? For instance, the strict enforcement of the terms '2 per cent ten days, net thirty days' indicates that the 2 per cent is an earning and not a deduction from the purchase price. As a general rule any discount in excess of the terms just mentioned may be treated as a trade discount."

Many accountants consider a discount greater than one per cent as a trade discount and it will be noted under the discussion of "Auditing Theory" on page 84 of this chapter, that the Federal Reserve Board advocates that any discount exceeding one per cent is to be treated as a trade discount, and if it has not been deducted from the invoices before recording them in the purchases book, there should be a reserve therefor set up in the Balance Sheet.

Doubtful Accounts. As soon as an account is known to be worthless it should be written off entirely; however, it frequently happens that an account will be past due at the end of a fiscal period, yet it is still considered good and it may not be wise to write it off as a loss. Some firms keep a doubtful accounts ledger, and when an account is past due and considered at all doubtful, it is written off the regular sales ledger and transferred to the doubtful accounts ledger. At the same time, a reserve is set up charging the current period with the estimated loss on such accounts. Other firms simply leave all accounts stand open in the sales ledger until they are either collected or are found to be absolutely worthless, and set up a reserve at the end of the fiscal period for an amount estimated to be sufficient to cover the loss. The Treasury Department will only allow as a deduction from income the actual amount of bad debts written off, but this doesn't mean that all doubtful accounts should be written off before determing to a certainty that they are uncollectible. Returns are always subject to inspection by Income Tax collectors or inspectors, and if accounts considered good by the inspector have been charged off they most certainly would not be allowed. Furthermore, any accounts written off and subsequently collected would be taxable as income in a later period. Of course, it frequently happens that an account considered worthless is later collected in full or in part. This should be considered as a special income.

2. AUDITING THEORY Quoting from the Federal Reserve Bulletin:

Aging Accounts. "The bookkeepers of the accounts receivable ledgers should be asked to draw off lists of the open balances at the end of the fiscal period, and distributions of the total columns should be shown on the lists according to the age of the accounts, e. g., not yet due, less than 30 days past due, more than 30 days past due. (This is known as aging accounts receivable). The accounts paid since the close of the fiscal period should be noted in the lists before taking up the matter of past-due accounts with the credit department, as payment is the best proof that an account was good at the date of the audit.

Schedules Agree With Controlling Accounts. “The totals of the lists of outstanding accounts should agree with the controlling account in the general ledger if separate ledgers are kept. When credit balances appear on customers' accounts they should be shown on the Balance Sheet as a separate item and not deducted from the total of debit balances; and debit balances on the accounts payable ledgers should be treated in the same manner.

Lists Verified. “The lists must be footed and compared in detail with the customers' accounts in the ledgers.

Accounts Past Due. "The composition of outstanding balances should be examined, as it frequently happens that while a customer may be making regular payments on his account, old items are being carried forward which have been in dispute for a considerable period of time. Such items and accounts which are past due should be taken up with the credit department or some responsible officer, and the correspondence with the customers examined, so that the auditor may form an opinion of the worth of the accounts and satisfy himself that the reserve for doubtful accounts set up by the company is sufficient.

Discounts. “Trade discounts (and also so-called cash discounts, if exceeding 1 per cent) and freights allowed by the company should be inquired into, and if they have been included in the accounts receivable, a reserve therefor should be set up in the Balance Sheet. Also inquiries should be made regarding customers' claims for reductions in prices and for rebates and allowances on account of defective materials, so that it may be seen that a sufficient reserve has been established therefor.

Accounts Assigned, Bad Debts, Deposits, etc. "Inquiry must be made as to whether any of the accounts receivable have been hypothecated or assigned, and the sum total of accounts so listed entered under 20b. (See page 41, Chapter Three.)

“The auditor should satisfy himself that the bad debts written off have been duly authorized by responsible officials.

"Accounts due from directors, officers, and employees must be stated in the Balance Sheet separately and not included as trade accounts. This applies also to deposits as security, guaranties, and other extraordinary items not connected with sales. "Accounts due from affiliated concerns must not be included as customers' accounts, even though arising as a result of trading transactions. Affiliated companies' accounts should be shown as a separate item of 'current assets' or as 'other assets', as the circumstances warrant. They may be fairly included as current assets' if the debtor company has ample margin of quick assets over its liabilities, including such accounts.

Verification of Accounts. "Optional.— The best verification of an open balance is a confirmation by the customer; therefore, if time permits and the client does not object, it is advisable to circularize the customers. The auditor should personally see the circulars mailed after comparing them with the lists of outstanding accounts. The envelopes for replies sent with the circulars should be addressed direct to the auditor.

"In large concerns the system of accounting is generally so arranged that it would be almost impossible for accounts to be paid and not correctly credited on the accounts receivable ledgers, but in small concerns, with imperfect systems, such occurrences are quite possible, so much so, in fact, that it is generally admitted that the risk of errors and omissions decreases in direct proportion to an increase in bookkeeping."

3. AUDITING PROCEDURE Space will not permit a detailed record of the auditor's work in connection with the verification of accounts receivable, therefore, we shall limit our discussion to an outline showing the procedure of the audit.

(1.) A transcript of the Sales Ledger controlling account in the general ledger was made showing a balance of $81,687.00.

(2.) The schedule of accounts receivable furnished the senior by Mr. Pond, the chief accountant, was checked with the sales ledger and it was found that the total of all the accounts with debit balances amounted to $84,721.50, while the total of those accounts which had credit balances amounted to $3,034.50.

(3.) Terms on which goods are sold, net 30 days, no cash discount allowed. Trade discounts are all deducted from the invoices and no accounts with these discounts is maintained in the ledger.

(4.) The junior next divided the accounts receivable into three lists: Those not yet due; those less than 30 days past due; and those more than 30 days past due. The results showed accounts amounting to $73,807.80 were not yet due, accounts amounting to $8,755.70 were less than 30 days past due, and accounts amounting to $2,158.00 were more than 30 days past due. After this was completed those accounts more than 30 days past due were taken up with the credit man and carefully analyzed.

(5.) It was ascertained that at the beginning of the year, January 1, 1918, the total of accounts receivable amounted to $51,200.00. A reserve for bad debts amounting to 2% was set up at that time. During the year accounts amounting to $970.00 were found to be worthless and were charged off by debiting the reserve account. These were found to have been duly authorized. Conversation with the credit man revealed the fact that the experience of the Company during the past five years indicated that their annual losses from bad debts amounted to approximately 2% of the total accounts receivable.

(6.) No accounts were found to be hypothecated or assigned.

(7.) No accounts from directors, officers or employees were found to be included in the accounts receivable; also that there were no deposits, guarantees, or any extraordinary items included. The credit balances noted in connection with a few of the customers' accounts were found to represent overpayments, allowances on merchandise returned and other allowances on account of just claims.

(8.) With the consent of the client, statements were made out and mailed to all customers. By means of a rubber stamp the following notice appeared on each statement:

Please examine this account immediately. If
incorrect, address J. F. Sherwood, Certified Public
Accountant and Auditor, 309 West Third St., Cin-
cinnati, Ohio.

4. INCOME TAX PROCEDURE Reserve for Bad Debts not a Deduction from Income. In preparing Income Tax returns the amount set up as a reserve for bad debts is not a deduction from income, only the specific debts actually charged off during the year may, be deducted. Income Tax Law.

Section 214.

(a) [Individuals). “That in computing net income there shall be allowed as deductions:

(7.) "Debts ascertained to be worthless and
charged off within the taxable year.".

Section 234. (a) (Corporations] "That in com-
puting the net income of a corporation subject to the tax
imposed by Section 230, there shall be allowed as de-
(5). "Debts ascertained to be worthless and charged
off within the taxable year.”

(*T. D. 2433, January 8, 1917) "Reserves to meet losses contingent upon shrinkage in values, losses from bad debts, capital investments, etc., are deductible only when definitely determined as the result of a closed or completed transaction and are charged off."

*Tax Decision.

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